Brussels faces a second anti-austerity revolt as the Portuguese Left tears up
the script and demands the right to govern

The delayed fuse on the eurozone's debt-deflation policies has finally detonated in a second country. Portugal has joined the revolt against austerity.

The rickety scaffolding of fiscal discipline and economic surveillance imposed on southern Europe by Germany is falling apart on its most vulnerable front.

The anti-austerity revolt in Portugal is a foretaste of what may happen in a string of EMU states when the global economic expansion rolls over

Antonio Costa, Portugal's Socialist leader and son of a Goan poet, has refused to go along with further pay cuts for public workers, or to submit tamely to a Right-wing coalition under the thumb of the now-departed EU-IMF 'Troika'.

Against all assumptions, he has suspended his party's historic feud with Portugal's Communists and combined in a triple alliance with the Left Bloc. The trio have demanded the right to govern the country, and together they have an absolute majority in the Portuguese parliament.

The verdict from the markets has been swift. "We would be very reluctant to invest in Portuguese debt," said Rabobank, describing the turn of events as a political shock.

The country's president has the constitutional power to reappoint the old guard - and may in fact do so over coming days - but this would leave the country ungovernable and would be a dangerous demarche in a young Democracy, with memories of the Salazar dictatorship still relatively fresh.

"The majority of the Portuguese people did not vote for the incumbent coalition. They want a change," said Miriam Costa from Lisbon University.

Joseph Daul, head of conservative bloc in the European Parliament, warned that Portugal now faces six months of chaos, and risks going the way of Greece.

Mr Costa's hard-Left allies both favour a return to the escudo. Each concluded that Greece's tortured acrobatics under Alexis Tspiras show beyond doubt that it is impossible to run a sovereign economic policy within the constraints of the single currency.

The Communist leader, Jeronimo de Sousa, has called for a "dissolution of monetary union" for the good of everybody before it does any more damage to the productive base of the European economy.

His party is demanding a 50pc write-off of Portugal's public debt and a 75pc cut in interest payments, and aims to tear up the EU's Lisbon Treaty and the Fiscal Compact. It wants to nationalize the banks, reverse the privatisation of the transport system, energy, and telephones, and take over the "commanding heights of the economy".

A durable rebalancing of the economy has not taken place... Portugal faces an acute growth challenge

International Monetary Fund

Catarina Martins, the Left Bloc's chief, is more nuanced but says that if the Portuguese people have to choose between "dignity and the euro", then dignity should prevail. "Any government that refuses to obey Wolfgang Schauble must be prepared to see the European Central Bank close down its banks," she said.

She is surely right about that. The lesson of the Greek drama is that the ECB is the political enforcer of monetary union, willing to bring rebels to their knees by pulling the plug on a nation's banking system.

These two parties have for now submited to eurozone pieties, agreeing vaguely to abide by EMU fiscal rules. Such lip-service is meaningless.

The EU Fiscal Compact requires Portugal to cut its public debt from 127pc to 60pc of GDP over twenty years, under pain of sanctions, with parallel cuts in Italy, Spain, France, and Belgium that feed on each other and are likely to trap monetary union in a contractionary vortex for another generation.

For Portugal it entails a primary budget surplus on such a scale that it cannot possibly be compatible with the economic agenda of the Left.

Mr Costa's own proposals - scarcely more moderate - put him on a collision course with the European Commission. He has vowed to "turn the page on austerity", reverse Troika cuts, roll back labour reform, review the privatisation of public transport and the water works, and launch a 55-point reflation package led by spending on health care and education.

The upset in Portugal has caught Europe's elites off guard. The eurozone is enjoying a cyclical rebound of sorts, driven by the happy trifecta of cheap energy, a cheap euro, and cheap credit. The ECB's quantitative easing has flushed the system with liquidity though Europe still has one foot in deflation.

Europe's leaders thought the crisis was over and believed their own propaganda that Portugal has successfully clawed its way back to safety by adhering strictly to Troika terms. This was always wishful thinking.

William Buiter, Citigroup’s chief economist, says Portugal has many of the same economic ‘pathologies’ as Greece, with debt ratios already beyond the point of no return, and a fresh solvency crisis almost inevitable in the next downturn.

Portugal's combined public and private debt is 370pc of GDP. This is the second highest in the developed world after Japan, but Japan is an international creditor while Portugal has net external liabilities of 215pc of GDP. "A systemic solution to the problem of excessive leverage is needed," says the International Monetary Fund.

The IMF praises Portugal's “export miracle” but warns that the gains have been narrowly based. While exports have jumped from 30pc to 40pc of GDP since 2010, there have been no such advances in "domestic-value added" shipments, which are what matter for competitiveness. “A durable rebalancing of the economy has not taken place and the nontradable sector is still dominant,” it said.

“Portugal faces an acute growth challenge. Productivity growth has been declining over the past half-century. Portugal’s working-age population is projected to fall, and the country’s capital stock is contracting because of underinvestment,” it said.

It is this mix of high debt and chronically low growth that is so toxic, compounded by deflationary forces that poison with debt dynamics. The IMF says the only sure way to escape the stagnation trap within EMU constraints is a blast of radical market reform. Yet reforms have already "stalled". They now look implausible.

The anti-austerity revolt in Portugal is a foretaste of what may happen in a string of EMU states when the global economic expansion rolls over, as it may well do within a couple of years on historical patterns.

The social and political damage caused by the eurozone's self-inflicted slump from 2008-2014 is still fermenting, a combustible atmosphere if the region is soon hit by fresh downturn.

The currency bloc is in worse shape on almost every metric than it was before the Lehman crisis. Debt levels are 35 percentage points of GDP higher. EMU-wide unemployment is stuck at 11pc. The credibility of eurozone leadership is in tatters.

Powerful populist forces are waiting in the wings in Spain, Italy, and France. The events in Portugal have shown that every election in Southern Europe is a now an "event risk". Political chickens are coming home to roost, and economic time is running out.